financial and managerial accounting read online

financial and managerial accounting read online

Exploring the Principles and Applications of Financial and Managerial Accounting

1. Introduction to Financial and Managerial Accounting

Every business, large or small, must keep records and produce financial reports on its business activities. These financial reports are critical to the management of any business, since they provide managers with the financial information needed to make informed business decisions. Sometimes, businesses are required to share this important financial information with stockholders, government officials, and financial analysts who serve people who are interested in the financial information as well as the managers. The process of gathering, summarizing, and reporting financial data to interested external users is probably as old as business itself. This process, or financial accounting, is most familiar to most people. However, financial accounting is but one component of the more comprehensive process of accounting. Businesses also emphasize the internal recording and reporting of financial data, such as information used by purchasing department managers, marketing managers, production managers, personnel managers and other operational managers. These managers need the financial data to make the many decisions necessary in the daily operation of business activities. The process of developing and using financial and other operational information to help make day-to-day decisions is called managerial accounting.

2. Fundamental Concepts in Financial Accounting

Accounting, since ancient times, has been the language of business. For example, the Sumerians (in Mesopotamia around 3000 BC) had a very similar accounting system to current double-entry accounting. In Rome, the managers used cash basis accounting to track the collection of taxes. And in 1494, the famous Italian friar Luca Pacioli – known as the father of modern accounting – initially developed the principles of accounting for transactions. The basic principle of these early financial accounting systems was to keep books of accounts that could be used to identify transactions at a given time and the result over a given period. Over the past 30 years or so, there has been a transformation in this system, from the manual process to computer software and systems. These systems have increased the volume of information available to stakeholders and the reliability of that information, providing for a more effective decision-making process. Along with the global economy, accounting is both a reflection of the organization’s current financial situation and its ability to generate value in the future.

Financial accounting plays an important role in all economic systems, providing valuable information for the governance of public and private organizations, as well as for the operation of financial and capital markets. From the business standpoint, it helps to ensure market efficiency, mitigate risks, and create access to finance and promote cooperation among organizations. It provides information on the cash generated or used by economic transactions, the volume and composition of assets, the sources and types of funding, and the results of operations and dividend distribution. From an organizational perspective, financial accounting has a legal and regulatory function related to the prevention of conflicts of interest between its own controllers and third parties – a reflection of the agency problem. It reports large transactions and the net assets of the organization, thus assisting all societal stakeholders to consider the right questions and make appropriate decisions.

3. Cost Behavior and Analysis in Managerial Accounting

Understanding cost behavior enables accountants to better forecast costs. Forecasting is not straightforward because many business operations, such as research, are subject to inherent uncertainties. There are several reasons to study cost behavior, the most important of which concern planning and decision making. The relationship between fixed, variable, and total costs of a company describes a cost equation used to forecast those costs for a given level of activity. Planning production involves selecting a level of activity and the flexible budget is a forecast, for this level of activity, of the company’s sales, expenses, and net income. Variance analysis, a part of the control process, concentrates on these differences. Finally, the breakeven point is the level of sales at which the company’s total revenue equals the total costs, yielding a profit of zero. Bureau management staffs frequently are provided with a copy of the annual breakeven analysis for their bureaus.

Take electricity costs for example. Assuming that the company has only light assembly work, electricity costs may be relatively constant. When production is increased to a moderate level, the cost of electrical energy per unit will remain constant; however, the total cost will increase progressively. If a company adds a third shift to increase production to an even higher level, the total cost of electricity will increase rapidly. Hence, costs may change as a result of shifts in production levels. Costs may also change as a result of increases in telephone call volume or as a result of increases in the number of shipments made. In order to forecast total costs, accountants must differentiate these behaviors in relation to changes in production volume.

Cost behavior refers to the manner in which costs change as some related activity changes. Understanding the behavior of a cost is necessary for efficient planning, controlling, and decision making. Costs usually behave in one of three ways.

4. Budgeting and Performance Evaluation

Budget Concept – Operating and Financial Budgets. A budget is a financial plan for the coordination of activities; that is, a detailed plan of operations for some specific future period. For a budget to accomplish the goals of planning and control, it is modified in numerous ways as its preparation progresses. All these modifications result in the budget becoming more specific, less flexible, and more reliable as a guide; that is, it becomes more difficult to alter budgeted plans without significant cost or inconvenience or without giving such departure from the budget the scrutiny of higher-level management or specialized cost-control experts. The operating budget is prepared first and is based on the master sales forecast. After the operating budget has been finalized, the dollar amounts of the various types of costs listed in the operating budget – sales and administrative, direct labor and manufacturing costs, selling, and other variable and fixed overheads – are summarized for the fiscal year or for some other convenient interim period to yield the financial budget.

Since budgets help coordinate activities and motivate personnel, planning and control are both much easier and more effective with them. In this chapter, we discuss what budgets are and how they can effectively be used in planning and controlling expenditures and in motivating managers.

Chapter 15. Budgeting

5. Ethical Considerations in Accounting Practices

In examining the code of ethics for the American Institute of Certified Public Accountants (AICPA), public accountants mention four ethical concerns including independence, objectivity, integrity, and credibility. The transactions recorded on accounting books are based on management’s explanation. Material misstatements in accounting books, particularly misstatements of liabilities and revenues, could lead to fraudulent financial reporting. The quality and nature of auditors’ working papers are not readily available to an interested party unless a lawsuit is filed and access is allowed in a court of law. Despite the profession’s claims of self-regulation, no system exists that requires auditors to report instances of clients’ fraudulent activities. Meanwhile, internal accountants have different codes of ethics, including competence, confidentiality, integrity, and credibility. Yet, like their external accounting counterparts, they too are employed by management, and their promotions and programs are determined by management.

Ethics are the cornerstone in any profession, including accounting. In fact, there is a structure for the code of ethics associated with financial accounting. The Financial Accounting Standards Board (FASB) is the entity responsible for establishing financial accounting standards in the United States. It has a specified principle for “the needs of the public (users) of financial information” to be recognized in every commerce. Although this structure is not directly responsible for an entity’s code of ethics, members of FASB believe that the specified principles are guides that members of Professional Accounting Associations will assume during their working lives.